Pensions, freedom and the search for income

The reforms to retirement funding offer investment companies a once-in-a-lifetime opportunity to sell their unique features, such as flexible and growing dividends  

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It is a little over four months since George Osborne uttered the words: “Let me be clear, no one will have to buy an annuity.” 

In the immediate aftermath, the focus of attention was on the impact this would have on the annuity market, most predicting its effective demise. I don’t think this is the end for annuities, though they may have to adapt to survive, and for some they will still be the correct choice. But in countries where annuities are not effectively compulsory, they make up only a small percentage of financial planning in retirement. So it is clear that we are looking at a fundamental change in the way people manage income in retirement.

More recently, the focus has been on the promised “guidance guarantee”, who will provide it and who will pay for it. Given that guidance has to be in place by next April, and might have to cater for some 300,000 people a year, the AIC recommended using the existing network of independent financial advisers paid for through a voucher scheme. 

The Government has now signalled that advice should be ‘impartial’, offered through organisations such as the Money Advice Service and paid for by a levy on regulated firms. This has provoked claims from advisory firms that they appear to be paying for guidance they are not going to give or benefit from.

This debate, though, should not distract us from the fact that April 2015 will herald in a completely new approach to funding retirement. For investment companies, this offers a real opportunity as it plays to one of their unique strengths.

Delivering income has been a massive story for the sector over the five years since interest rates collapsed. It has figured in nearly all the IPOs in the past couple of years, and existing companies with a strong income story are in such demand that many have moved to a premium rating and are having to issue new shares to meet demand.

Other funds can offer income, of course, but it is the unique features of investment companies in delivering a higher and growing income that have clearly caught investors’ attention. They are not, and never will be, a substitute for annuities but, for those who can accept the risks, they are an obvious candidate for part of a balanced, long-term income portfolio.

Unlike many other funds, investment companies are not required to pay out their income each year but can hold some back in good times to pay out in leaner periods. So when banks and other high-dividend-paying companies such as BP cut or stopped paying dividends in recent years, open-ended funds saw their dividends drop as a result. 

Some investment companies, by contrast, could use their reserves to maintain or even increase dividends. 

Our Dividend Heroes research suggests that in a few years we will have our first members to have increased dividends each year for more than 50 years.

This flexibility to manage income over the cycle is also supported by the closed-ended structure. Investment companies are not restricted, like Ucits funds, to investing in listed shares and securities. Many of the asset classes that offer a high income (infrastructure, commercial property, renewable energy, etc) are illiquid in nature and so are much better suited to a closed-ended fund.

Finally, investment companies now have the flexibility to use their capital profits to pay out dividends and are not simply reliant, like other funds, on the income they receive from their investments. This is likely to be used sparingly, but many income investors see a steady, rising income, without any surprises, as almost as important as the initial income. 

What is not in doubt is that, for investment companies at least, the Budget reforms provide a once-in-a-lifetime opportunity to talk about features of the sector that other funds cannot offer.

Ian Sayers, director general, AIC

ITs